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Wednesday, June 10, 2015

Recent Buy: Facebook (NASDAQ: FB)

One of my investing strategies, as discussed in my previous post, is to invest in companies that have a strong competitive advantage and very minimal (if any) competition within their respective industries. I also like to look at companies with a strong network effect. As per Investopedia:

"[network effect] a phenomenon whereby a good or service becomes more valuable when more people use it."

There is no doubt that Facebook (NASDAQ: FB) has become a phenomenon all around the world. I still remember when I was first introduced to Facebook in 2004 while still in college. I would have never guessed in my wildest dreams that the website would become as valuable as it has.

When the company first introduced its IPO in May of 2012 I was very skeptical and decided to stay away. Despite the website's popularity, I was unable to see a clear picture of how exactly this "free website" would make money for investors. I failed to recognize (back then) the potential that came from driving revenue from advertisers, marketers, developers, and from the users themselves.

I took some time to do my own research and analysis and decided to start a small position in this company about a month ago. Below are some of the factors that I found most notable and promising and why I've become a shareholder.

I. Significant growth in revenue year over year

I'll start by talking about top line growth, or revenue, for the most recent quarter (first quarter of 2015), which came in at $3.54 billion, a very healthy 42%year over year increase in comparison to the $2.50 billion reported during first quarter 2014. Diving in to a more specific breakdown; revenue from advertising (which is Facebook's main driver of revenue) increased46% year over year. Mobile advertising revenue (in simpler terms, revenue from people using Facebook from their smart phones) represented a staggering 73% of the total advertising revenue, an increase of 59% on a year over year basis.

The increase in revenue is not an outlier. Facebook has been reporting healthy revenue increases year over year since becoming publicly traded:

If you were wondering whether the above noted data makes any sense; it may be good to look in to how daily active users coming from mobile are increasing quarter after quarter. Facebook reported that DAU (number of people using Facebook daily) increase by 17% year over year to 936 million people. Monthly active users increased 13% year over year to 1.4 billion.

When we look at mobile active users is when things really get interesting. If you take a closer look at FB quarterly reports, you may notice the company didn't officially start reporting number of Mobile Daily Active Users until 2nd quarter 2014 (the metric was originally embedded within daily active users numbers and reported on a monthly basis). I can only deduct that this metric has become too important to ignore and thus, it has earned its own special category in Facebook's earnings reports.

For first quarter 2015; Mobiledaily active users came in at 798 million on average, an increase of 31% year over year. Mobilemonthly active users came in at 1.25 billion, also increasing by 24% on a year over year basis.

III. The Future of Mobile: Why is growth in Mobile revenue important?

A 2013 study by International Data Corporation (IDC), found that 79% of the population keeps their smartphone at arms length for about 22 hours per day. The data shows that eventually, about one out of four people will have their phones at arms length 100% of the time. In terms of what are exactly people doing with their phones- 16% of the time is spent on phone calls while 84% is spent on other activities including browsing the web, email, social applications, watching videos or playing games.

The same study showed that after checking their email, people spent most of their time on their Facebook application. As per the IDC, while 78% of the time is spent on email, 70% is spent on Facebook for those people with a smartphone.

It is expected that by 2018; mobile data traffic will increase at an annual growth rate of 61%.

IV. The Future of Marketing and Advertising

The marketing budget of mayor corporations allocates only a very small percentage to Facebook advertising representing tremendous amount of opportunity for further revenue growth as companies catch up to rapidly changing times in advertising techniques that may be more efficient, strategic and may provide a more significant return on investment.

A research study conducted by Mondo entitled: "The Future of Digital Marketing", released in January of this year, showed that 80% of companies plan to increase their digital marketing budgets within the subsequent 12-18 months. The demand for hiring the best talent within this niche is reinforced by the findings which indicated that the top skills companies are looking to hire for this year includes digital/social (54%), content creation (44%), big data/analytics (33%) and mobile strategy (30%). The way things are moving in this industry, I can only see these number continue to ascend in the years going forward.

V. Other factors to consider

Where is the Money going? Research & Development

The hefty increase in cost and expenses reported by the company in the most recent quarter may scare many. There is no denying that Facebook competes within a fiercely competitive technology industry and it's ability to maintain its competitive advantage significantly depends in it remaining relevant and innovative. Hence, it should come to no surprise that the company spends heavily in hiring talent that is able to develop new products and/or maintain an infrastructure that is constantly providing value for the customers Facebook serves including users, marketers and developers.

The company reported a 88% increase in R&D expenses year over year from 2013 to 2014. Same was attributed to the following: "The increase was primarily due to an increase of $724 million in share-based compensation expense compared to 2013, and an increase in other payroll and benefits expense resulting from a 48% growth in employee headcount from December 31, 2013 to December 31, 2014 in engineering and other technical functions. Share-based compensation expense also increased due to the acquisitions we completed in 2014."

Facebook relies heavily in human capital and thus, these type of expenses do not scare me and should not deter you either. Without solid talent, the company would be unlikely to continue growing to its utmost potential.

Valuation

The stock's current valuation may come across as too rich for many. Company trades at a P/E of 80x earnings, forward P/E of 32.4x earnings and the stock price is at about 4% from its 52-week high. For comparison purposes, the S&P 500 current P/E is at a ballpark of 18.5x earnings. In terms of companies in a 'similar' industry (because, lets face it, there is really nothing like Facebook) Google's (NASDAQ: GOOG/GOOGL) currently trades with P/E of 26.5X earnings and forward P/E of 16.5.

Final thoughts

Based on extensive amount of research, it is my opinion that Facebook presents solid upwards potential, especially for long term investors. The company is well positioned when it comes to mobile usage and what they can offer advertisers. The face of marketing is changing drastically and when corporations fully catch up, Facebook will be there to benefit.

Although the company's costs are increasing rapidly, the continuous strategic investments in research and development is something that is indispensable to ensure the company remains competitive, continues to grow, and remains a leader within its industry.

As with any company, no success is ever guaranteed and no one has a crystal ball about what the future may bring. I'll continue keeping an eye on trends including daily active users across the board, revenue growth, and how the company spends their money- either through strategic acquisitions and/or continuous improvement of the company's infrastructure to better serve all different segments in which Facebook is involved. As long as my original thesis for this company stays the same, I may continue adding to my position during pull back and/or market corrections.

Tell me, what are YOUR thoughts on Facebook as an investment?

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Disclosure: LONG on FB, GOOG/GOOGL*Never invest or cease to invest based solely on the information provided on this blog.